To contend with higher tariffs, businesses need to act now

With higher tariffs likely under the incoming Trump administration, businesses are already making decisions in a way that will affect economic growth and reshape the global economy.

We are already getting questions on pulling forward expected orders for durable goods to avoid the increase in tariffs that could begin soon after President-elect Donald Trump takes office on Jan. 20.

Although the size and scope of the tariffs are unclear, American firms are already preparing for the likelihood of higher tariffs on goods made in China.

Pulling forward durable goods orders would bolster U.S. gross domestic product, which is tracking at around 2.4%. But it would also potentially create cash flow issues and thinner margins for firms caught in a narrow time frame to act.

What to do over the longer term is another consideration. Businesses are asking us about relocating their supply chains to more expensive economies that have trade treaties with the United States, or to regional economies that are likely to escape new tariffs.

However it plays out, firms need a sense of urgency to avoid being caught unprepared for a higher-tariff environment, where substituting foreign imports with domestic goods could be mandated. Firms also need to conduct a broader reevaluation of their sourcing, production and distribution operations.

Import substitution as a policy failed when emerging markets tried it in the middle of the 20th century. But such policies are the bedrock of economic populism and will be implemented next year in the U.S.

Unsurprisingly, firms are telling us they are trying to avoid increased taxes on imported Chinese electronics by diversifying their supply chains. Firms are also considering longer-term strategies that involve moving production facilities into the U.S., Mexico or Vietnam.

It is too early to estimate the macroeconomic dislocation or microeconomic distortions caused by the incoming administration’s harder-line trade policies.

But it is not too early for American firms to begin taking action.

Tariff mitigation

In the era of economic populism, tariffs will play a much larger role in the economic life of firms.  

The question, then, is how to reduce the impact of these higher costs. The goal should be to mitigate the potential increase by 50% and to remain competitive with other firms facing the same challenge.

Tariffs are taxes levied on imported goods used in the production of intermediate or finished products, paid at the point of entry of a country. Those tariffs tend to reduce profits among businesses, which pass along the higher costs to customers.

One-time tariffs raise prices, which in turn put upward pressure on inflation. The one-time tariffs tend to affect the microeconomy of that particular industry far more than the macroeconomy. But should the tariff lead to a broader trade war, a disruption to the macroeconomy cannot be discounted.

In addition, since economic populism tends to embrace expansionary fiscal policies like tax cuts and government spending that are not paid for, Congress could impose binding and far-reaching import taxes to partially offset the revenue shortfall and avoid a spike in long-term yields that would be caused by such fiscal policies.

It would not be surprising if the border adjustment tax, a consumption tax that was considered during the first Trump administration, resurfaces to partially finance tax and spending policies.

Tariff mitigation strategies should be understood as an analytical framework that firms use to diminish the impact of increased import taxes on their operations.

But the time to act is now. 

7 strategies

For firms with exposure to higher tariffs, we offer seven strategies that can help reduce the impact in the near term and longer term. 

1. Pulling forward orders: The first step for firms with exposure to a steep increase in tariffs is to pull forward orders of durable goods, software and intellectual property that may be subject to higher trade taxes. Firms must map out the risk to their operations as well as both direct and indirect risk through imported products when determining how much cash flow and credit needs to be allocated toward immediate purchases to avoid rising tariffs.

2. Diversification: Firms can take immediate steps to diversify their supply chains when tariffs are quickly imposed through executive action. But there are longer-term strategies as well.

• Near term: Sourcing from other countries that have trade treaties with the U.S. or economies that have lower tariffs on trade is a first step. Substitution of nontaxed inputs from tariff-friendly countries to keep production costs under control should also be considered.
• Medium term: Establish sourcing through different regions to create operational flexibility and avoid increasing costs. This may involve multiple production locations in free-trade zones or tariff-free economies and the finishing of production in the U.S.
• Longer term: Adopt nearshoring through the moving of production to inside the North American trade zone or dollar bloc of countries that include Mexico, Canada, the UK, the European Union, Japan, South Korea and Australia. This may involve strategic ventures and partnerships between large and medium-size global firms that may want to establish external production capabilities and local assembly ventures to reduce or eliminate tariffs.

3. Short- to medium-term storage: Purchase and store goods in economies that have free-trade treaties with the U.S. with the objective of deferring or eliminating tariffs. Until goods are sold or reexported, this strategy can help reduce higher trade taxes until initial cash flow shocks dissipate.

4. Trade-duty refunds and valuation: One of the older trade programs in the U.S. is the duty drawback, which is used to stimulate domestic manufacturing and exports.

• Under such programs, a majority of taxes can be recovered through drawbacks. While these programs, which are run by U.S. Customs and Border Protection, can be complex and time-consuming, they should result in more efficient inventory management.
• Where possible, firms may reduce the value of declared goods to reduce the cost of imports. Many tariffs are estimated based on the goods value.

5. Product exclusion and subsidies: Engage in both direct and indirect lobbying of the administration, particularly the U.S. trade representative, to secure product exclusion. Lobbying, though, can be costly. In addition, if one sector of the economy is hurt by a steep increase in tariffs, such as U.S. agriculture was during the 2018−2020 trade skirmish between the U.S. and China, direct executive or legislative action may be taken to offset the loss of income.

6. Passing along costs: The simplest form of cost mitigation for firms facing potential new tariffs, tax policies and nontariff barriers in the coming years will involve passing these costs through to customers. Such an action would create competitiveness challenges in an industry hit by tariffs while burdening households with higher prices.

7. Hedging strategies: Larger firms may have the financial resources to engage in hedging tactics and strategies to avoid costly currency fluctuations. While tariff regimes tend to be associated with a strong domestic currency, that is not always the case in some currency pairs. Hedging may make sense under certain circumstances. 

The takeaway

Higher tariffs are likely over the next few years. In our estimation, firms do not have the luxury to wait and see how the policy changes turn out.

We have already talked to firms that are pulling forward economic activity to avoid a tax shock that is likely to occur early next year. In addition, we have put forward seven strategies, for both the short term and the long term, to mitigate such a radical change in trade policy.